We have been saying for quite some time the trend to passive investing has been draining liquidity from the stock market, and yes, several factors are contributing to that drain. Still, no one seems to be concerned about this negative impact of passive investing. Yet the more money that gets locked into long term buying and holding of index funds, the less there is left to support the trading of stocks in the open stock market. The movement of large institutional investors into private equity and venture capital investing also aggravates this liquidity drain.
The coronavirus COVID-19 has generated an explosion of volatility as investors rush for the exit door, but rather than complaining about this rapid escalation of volatility, and viewing it as Wallstreet does as a measure of risk, we should work to find ways to turn this volatility into a profit-making opportunity, and take Warren Buffett’s words to heart when he says that rather than equating volatility with risk, we should view it as our friend. It is very easy to see what he means in today’s stock market as the small and midcap stocks get creamed daily as the public raises cash. We see movements both up and down of 5% to 10% in individual stocks.
The selling appears very indiscriminate, and many profitable and well-managed companies have seen the stock price declines of 50-70% from the stock market high on February 19, 2020. This presents a buying opportunity, and even if we have not yet seen the bottom, there are many attractive prices currently available.
It is, as always, a selective opportunity as some of the stocks that have been struck down may not recover. As always, when we have a bear market of this magnitude, it is likely to change the leadership going forward, and the stocks that have been leading the stock market in the last bull market will not lead the next.
I guess with the stock market up 31% last year, we should not have been shocked that we were due for a correction, but the source and speed of the correction have been breathtaking. The prolonged bull market had introduced a good deal of speculation needed correction, so now that the tide has gone out, we are quickly finding who has been swimming naked.
The long period of very low interest rates has encouraged the accumulation of a large amount of debt in specific areas of the stock market, and now these excesses will be corrected. In the energy sector, the shale producers have been given access to large amounts of debt to fuel their expansion. With oil prices below $25 a barrel, most of these producers will be losing money, and it the prices stay this low for an extended period, it will lead to bankruptcies and consolidations.
It is to try soon to predict an end to the carnage. Still, the recent governmental $2 trillion of fiscal stimulus and 1.5 billion in monetary stimulation by the Fed, together with the current budget deficit of $1 billion should be enough public sector spending to fill a huge hole in the private sector spending.